Since the housing bust and economic downturn in 2008, some economists have been trying to steer policy toward solutions to correct the massive value surrendered by U.S. homeowners. It’s easy to understand why they’ve targeted this area. Government records reported last week show that U.S. wealth dropped 39 percent between 2008 and 2010, most of it on $1.7 trillion in home-value losses.

Krugman estimates housing prices being 8 percent higher in 2017 than today. But, he said, “if we could manage 4 or 5 percent inflation over that stretch, so that prices were 25 percent higher, the real value of mortgage debt would be substantially lower than it looks on current prospect — and the economy would therefore be substantially farther along the road to sustained recovery.”

Let the Genie Out of the Bottle?

Like Bernanke, Zillow Chief Economist Stan Humphries has serious reservations about the impact of inflation. He suggests higher rates of inflation are no way to spark recovery. In fact, Humphries points out that the market already has begun correct itself.

One of the early arguments for increasing the inflation rate targeted by the Fed was to increase home prices and stop the cycle of buyers sitting on the sidelines, scared of falling home values, which only served to further suppress demand and lower prices,” Humphries said. But I think this cycle has now been broken by the market itself as historical affordability has combined with stabilizing home prices and better general economic data to get people off the fence and buying homes again. Evidence of this is that both existing and new home sales have been up about 10 percent from year-ago levels in recent months.”

Humphries said there are more risks than rewards with such a policy because higher inflation is not helpful for savers, those with variable-rate debt such as credit cards and adjustable-rate mortgages, and typical consumers who could see prices for everyday items rise faster than their wages.

And the real danger with letting the inflation genie out of the bottle is that we won’t be able to easily get it back into the bottle, and it will get out of hand. It’s messing with real fire much more so than other policy tools used by the Fed.”

More Economists Weigh In

Still, Krugman — whose new book is “End This Depression Now!” — has been joined lately by other economists.

A little bit of inflation would do a whole lot of good for the U.S. economy, would certainly do a lot of good for the housing market. If we had just a little bit of inflation and house prices went up, all the sudden they’d be above the mortgages.”

In the case of the U.S., policymakers need to offer schemes to write down underwater mortgages, perhaps in return for other concessions such as giving the lender a share of any future home price appreciation.
If direct approaches to debt reduction are ruled out by political obstacles, there is still the option of trying to achieve some modest de-leveraging through moderate inflation of, say, 4 to 6 percent for several years. Any inflation above 2 percent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures.

The logic is simple – moderate inflation for several years would terminate at an earlier juncture the buyer’s ‘waiting game’ in the housing market. Once the deflationary dynamics end, the pent-up demand for houses will be released. The timing game will switch from waiting to ‘rush to buy’. Chances are that this will signal the end of the housing slump, and will invigorate construction.
For the U.S., there is strong statistical evidence that higher inflation increases household net equity in housing. Over the period 1957 to 2001 (just before the housing boom), net housing equity rose faster with inflation; each 1 percentage point increase in the price level was associated with around a 1.15 percentage point increase in equity, after controlling for income growth.

Redistributed Wealth Via Housing Collapse

While the debate about whether to implement new interventionist policies swirls among economists, they’re all in agreement that the busted housing bubble is a critical part of the country’s foundering economy.

“A bubble’s collapse redistributes wealth from borrowers to creditors,” says Atif Mian, a finance professor at the University of California at Berkeley’s Haas School of Business.

“Millions of borrowers have seen the value of their principal asset — their home — fall. Since they still owe whatever they borrowed during the boom, their consumption suffers while they struggle to repay.”

About the Author

Laura Vecsey is a former sports columnist, news reporter and politics writer and has worked for the Seattle Post-Intelligencer, Baltimore Sun, Albany (N.Y.) Times-Union and Harrisburg Patriot-News. She was also a regional editor with Examiner.com. She is a graduate of Sarah Lawrence College.

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